When Should Borrowers Refinance Their Mortgages?

Jeff Brown

The Federal Reserve says it will raise interest rates steadily in 2017. Bond yields have been rising in anticipation of more government borrowing in the Trump era. And mortgage rates have been drifting up, with the 30-year, fixed-rate loan now averaging 4.32 percent compared to 3.8 percent in June, according to the Mortgage Bankers Association.

That's not a huge increase, but what if it keeps going up? Should mortgage shoppers hurry to beat more increases? If you want to buy a home, should you get a move on? Is this the last best chance to refinance? What's best, a 30-fixed loan, a 15-year, or an adjustable-rate deal?

Making the wrong step could add tens of thousands to your costs over the years. It could diminish the home's value as an investment, leaving you with less to pass on to heirs or to tap in retirement.

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But don't panic. Anyone thinking of getting a new mortgage would be wise to move before rates climb too high, but can afford to shop carefully because the drift up should be slow, according to most experts.

"Remember, historically, mortgage rates have been much higher than today's rates," says Paul Ruedi, CEO of Ruedi Wealth Management in Champaign, Illinois. "While it will likely be awhile before we see the 6- and 7-percent rates of the past, if you are contemplating a move or refinance, do it now."

"We can expect rates to take a gradual move upward through 2017 barring any terrible economic news," says Bruce Ailion of Re/Max Town and Country in the Atlanta area. "It is expected that the U.S. will borrow heavily to support infrastructure spending and tax cuts. This will put a strain on interest rates."

At the same time, he adds, there are some downward pressures on rates from high demand from foreign investors for U.S. bonds. "The U.S. remains a haven for most of the rest of the world and, unlike Germany, our rates while low are at least positive. This moderates what would otherwise be a sharp increase in rates."

With the spring home-shopping season approaching, anyone looking to buy would be wise to take initial stops like checking the credit rating, assembling cash for a down payment and considering what type of loan to get.

"The impact of a possible Fed rate hike will be psychological," says Elizabeth Ann Stribling-Kivlan, president of Stribling and Associates, a New York City firm that specializes in luxury properties. "Rates are still incredibly low. Fifteen years ago, rates were in the double digits. Money is still unbelievably cheap. I think this is absolutely a time to buy as rates could go up, and sitting on the fence is not going to pay off."

Anyone sitting on an older mortgage with a high rate can consider refinancing, which makes sense any time the savings from a new, lower rate are large enough to offset the refinancing costs during the period you're likely to have the mortgage. A borrower with an old mortgage at 5, 6 or 7 percent is likely to come out ahead with a new one at just over 4 percent. But since loan rates have been in the basement for years, there may not be many of those high-rate loans around anymore.

Keep in mind that if you take out a 30-year loan to pay off the balance on an older loan with only 10 years to go, you'll be adding 20 years of interest payments. So look at the figure for total interest paid over the life of the loan, not just the monthly payments of the old and new deals. Also tally the interest costs for the number of years you're likely to have the new loan and the remaining interest costs on the old one.

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Refinancing can make sense even if the homeowner already has a loan with a pretty low rate, says Casey Fleming, Author of "The Loan Guide: How to Get the Best Possible Mortgage."

"If you are refinancing to consolidate an equity line, change from an adjustable-rate mortgage to a fixed-rate mortgage, or to pull cash out of your home, your needs are entirely different and it may still make sense to investigate," Fleming says.

Another option: the 15-year, fixed-rate loan, which will be paid off twice as fast as the standard 30-year deal.

The average 15-year loan charges a tad less than the 30-year -- 3.56 percent versus 4.32 percent. Over the long term, that reduces the borrower's interest costs, largely because interest is paid for only 15 years instead of 30. Lenders can charge less because they don't risk facing higher borrowing costs themselves after 15 years or missing out on the higher rates they might be able to charge in years 15 through 30.

But to speed up the payoff, the borrower must pay more each month toward principal. So a 15-year loan makes sense only if you can afford that higher payment -- $718 per month on a 15-year for every $100,000 borrowed at 3.56 percent, versus $496 per month on the 30-year at 4.32 percent.

With a 15-year loan the borrower is committed to those higher payments. One strategy is to take out a 30-year loan and make higher payments voluntarily. The interest rate won't be quite as low but paying the loan off early will still produce substantial savings in the long run. And the borrower can cut back to the smaller required payment on the 30-year deal if money is tight.

Adjustable-rate loans have not been popular in recent years, because borrowers have been eager to lock in the historically low rates offered on fixed-rate loans and don't want to risk being hit with higher rates on annual ARM adjustments. Currently, a 5/1 ARM that starts adjusting annually after five years charges just 3.37 percent during the first 60 months, the MBA says.

That "teaser" rate is lower than you can get on a fixed-rate deal, but after 60 months the rate can start moving higher, perhaps to more than the borrower could have got on a fixed-rate loan. So an ARM is a bet on future rates that makes sense only if one will have the loan for just a short time or is convinced loan rates will stay low. Today, rates are more likely to climb than fall.

"If you are going to be in your home for more than five years, it would be irrational to use an adjustable rate mortgage," Ruedi says.

But as rates drift up on fixed-loans, the low starting rate on an adjustable looks more and more attractive to borrowers, says Ray Rodriguez, regional sales manager in the metro New York area for TD Bank.

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"I do expect that we will see more demand for adjustable rates in the upcoming year," he says.

Jeff Brown spent nearly 40 years as a newspaper reporter, columnist and editor, including 20 years writing about investing, personal finance, the economy and financial markets. He spent 20 years at The Philadelphia Inquirer and has been freelancing since 2007.